The real cost of the insurance commissions paid to owners corporation managers is not only financial. Insurance commissions create a conflict of interest for the manager, incentivise managers to underperform and break down trust in the manager-client relationship.
At Stratablox, we are against insurance commissions. We believe that owners corporation managers should quote and charge management fees based on their assessment of the unique service requirements of buildings and their owners. Simple and transparent fee structures, without commissions, promote trust and will set the foundations for strong long term professional relationships.
Financial cost
The Strata Community Association (SCA), of which we are a member, continues to endorse the practice of manager’s deriving insurance commissions paid on behalf of owners corporations. The SCA endorsement is expressly conditional upon the commission not exceeding 20% of base premium and that ‘the best interests of the client remain the paramount criterion’. Base premium is the cost of the total premium before commission, stamp duty and GST are added on.
SCA have produced their own materials in support of continuing the industry standard of managers receiving insurance commissions, we do however respectfully disagree. We argue that a commission-free remuneration model is the better way to ensure the best interests of the client are upheld and protected.
The majority of management contracts we see from our competitors have set the insurance commission at the maximum SCA endorsed rate of 20% of base premium. In addition, the owners corporation must pay GST and state government stamp duty on the manager’s insurance commission.
The manager’s commission works out to be approximately 14% of the total premium, before GST and stamp duty, or 16.7% of the total premium (after stamp duty and GST are added). These additional costs are rarely understood by owners and managers that receive commissions are not naturally inclined to disclose these add-on costs in a simple and transparent manner.
In dollars, what does the owners corporation actually pay?
Let’s take a look at the example of an insurance premium of $10,000 per annum. These are the figures that owners should be aware of.
Total insurance premium: $10,000.00
Manager’s Commission: $1,400.00 (Approx 14% of total premium before GST and Duty)
GST on Commission: $140.00 (10% of Commission)
Stamp Duty on Commission: $154.00 (10% of Manager’s Commission including GST)
TOTAL COMMISSION: $1,694.00
In the simple example above, the owners corporation is paying $1,694.00 because of the requirement to pay the insurance commission, GST and stamp duty. To put it another way, if this owners corporation were to engage a manager, such as Stratablox, that does not take insurance commissions, this owners corporation’s total insurance premium would reduce from $10,000 to $8,306.
It is poorly understood amongst strata owners that owners corporation management companies quote artificially low fees to appear attractive and competitive. Only if you at look at the SCA contract of appointment closely will you see that the seemingly low management fee is subsidised by the 20% insurance commission.
Even once you know the 20% insurance commission exists, the actual dollar amount of the insurance commission would take further investigations to ascertain. For this reason, we encourage anyone reviewing an owners corporation management proposal to make use of our approximations above, or simply speak with us and we can tell you what you are really paying.
The behavioural cost – is your owners corporation manager incentivised to underperform?
Commissions in the context of employment and sales are typically designed to motivate desired behaviours and reward outcomes. If the employee works hard and gets great sales results, they earn some extra payment for their achievement by way of a commission. The commission is a win-win for the employer and employee and the reward model makes good sense in this context.
For owners corporation managers receiving insurance commissions, the context is very different. Your manager receives more commission if the insurance premium paid by your owners corporation is higher.
If you were part of an owners corporation tasked with designing a commission structure to motivate and reward great managerial performance and outcomes, would you design a commission system that rewarded your manager for increasing the cost of your insurance premiums? We think that a rational owners corporation would strive for the opposite. That is why we say the commission model creates perverse incentives and there are real world consequences for owners corporations that flow from this.
What are the potential real world consequences of the outmoded insurance commission model?
- Conflict of interest: The manager has a financial interest in which insurers are approached, shortlisted or ultimately approved. There are some insurance companies that do not provide insurance commissions to managers – has your manager approached any such company for a quotation?
- Lack of trust: As an owners corporation member, it is difficult to truly trust that your manager has sourced the best insurance options for you to consider. Should committee members undertake their own investigations to verify what they are being told by their manager and, if so, is the owners corporation receiving value from their manager when they are having to make insurance enquiries themselves?
- Reward your manager for under-performance: The owners corporation manager’s own underperformance might lead to higher insurance premiums. For example, failure to arrange building repairs and maintenance or failure to establish an adequate maintenance fund over time leads to a greater number of insurance claims being made. As the insurance claims history worsens, the insurance premiums increase and your owners corporation manager financially benefits from their own mismanagement.
- Reduced remuneration for exceptional performers: The inverse of the above is that a manager that performs exceptionally well and achieves a reduction in the insurance premium, receives a reduced commission.
- Commission has no correlation with management service requirements: The dollar amount received as an insurance commission has no relationship to the time, skill and effort required to obtain the insurance policy for the client, nor does it have any direct relationship to the time, effort and skill necessary to manage the owners corporation. For example, a heritage listed stone building may cost twice as much to insure than a modern building with cement and glass facades, simply because the cost of materials and therefore reconstruction would be more. Time, effort, skill and expenses for managing the heritage stone building are no more, yet the manager receives twice the insurance commission compared to managing the modern building. This situation does not promote economic efficiency in the provision of services.
The great myth – insurance commissions cost you nothing
Having worked in the strata industry for many years, I have heard insurance commissions being justified many times by the claim that insurance commissions do not cost the owners corporation anything. The great myth is that if the insurance commission is not paid to the manager, the amount charged by the insurer would be the same.
The truth is that when insurance quotations are sent to the owners corporation manager, the amount payable as an insurance commission is clearly specified. If the owners corporation manager reverts to the insurer (or broker) to advise that the manager does not require an insurance commission, the insurer has, on every occasion we have witnessed, reduced the premium by the exact amount of the manager’s commission (including the GST and stamp duty component of the commission).
Our tips for navigating the murky waters of insurance commissions
Stratablox recommends owners corporation members insist upon full disclosure from their manager regarding insurance commissions. Whether you are sticking with your current manager or weighing up alternatives, the key questions to consider are:
- What is the dollar value of the insurance commission paid by the owners corporation, including GST and stamp duty?
- What is the total remuneration received by the manager, once the dollar value of the insurance commission is known? (Annual fees, disbursements, commissions, additional services etc.)
- Does the manager understand the conflict of interest and if so, what steps have been put in place within the management company to ensure that the best interests of the client are upheld above the manager’s financial interest?
- What process will the owners corporation manager use to source insurance quotes for your owners corporation and, in particular, will the manager obtain quotes from insurers that do not pay insurance commissions?
One final thought on this matter. Readers may recall a film released in 2010 called Freakonomics: The Movie. Real estate agent commissions are discussed in the opening segment by economists Steven D. Levitt and Stephen J. Dubner. Importantly, there is commentary at the end which sums up commissions and human behaviour well, which applies equally to owners corporation managers as it does to real estate agents:
“It’s not that real estate agents are bad. It’s just that they’re human beings and human beings respond to incentives. If there’s only one element that I say is there in almost everything we do it’s the idea that incentives matter and if you can figure out what people’s incentives are you have a good chance at guessing how they are going to behave”.
We hope you enjoyed this article from Stratablox and found it informative. If you would like to discuss this article or other concerns you may have about your owners corporation, we would love to hear from you.
Julian Louey
Managing Director at Stratablox
www.stratablox.com.au